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How to Save Your Legacy From Chris Christie

This is a very busy time of year. Holiday insanity is (finally) over, and we actually have to go to work for a full work week. Time to play catch-up at work and in life.

Which makes this a great time to think about estate planning. You’ve spent hours in shul asking Hashem to help protect you and your family in the coming year—this is your chance to do your part and protect your family.

Which leads us back to life insurance. In our last article we discussed how life insurance impacts your estate plan. We discussed the case of Harry and Wendy who died tragically in a plane crash leaving two young children, Ruben and Simon. Harry and Wendy each had $2,000,000 life insurance policies and other assets (house, bank accounts, investments, retirement assets) totaling $1,350,000. Therefore, their combined estate is valued at $5,350,000.

Assuming Harry and Wendy had wills, and in those wills they gave options for the executor to create certain kinds of trusts, so that Harry and Wendy were able to shield $1,350,000 of their estate from New Jersey estate tax, that would leave $4,000,000 ($5,350,000—$1,350,000) subject to New Jersey estate tax. The total New Jersey estate tax would then be approximately $306,800.00.

That’s $306,800.00 going to our governor to pay for his travel to and from the next debate in Colorado on October 28. That’s not what Harry and Wendy wanted for their children.

This article is about a better plan for Harry and Wendy that uses an Irrevocable Life Insurance Trust (ILIT).

But before we talk about how an ILIT works, let’s talk about trusts. There are generally two types of trusts: revocable trusts and irrevocable trusts. An ILIT is an irrevocable trust. We will talk about the basics and benefits of revocable trusts in a future article, but if you’ve ever listened to Suze Orman, you know she is a BIG fan of revocable trusts. In fact, I’m grateful Suze isn’t an attorney so that I don’t have to split any fees with her for all of the clients that want revocable trusts because of her!

Back to trusts. Think of a trust as a box with instructions on the side that describe what happens with the assets in the box. The person who creates and usually funds (i.e., puts assets into) the box is the grantor (or settlor). The person who manages the assets in the box is the trustee. The box is created for the benefit of beneficiaries.

In the case of the ILIT, the grantor is the one who would (hire an attorney to) create the box/trust for the benefit of his wife or children. The grantor would appoint a trustee to manage the box/trust, and to take out a life insurance policy on the life of the grantor. The owner of that policy would be the trustee, and the life insurance policy would go into the box/trust. Thus, the policy would sit in the box/trust and remain in the box/trust until the grantor’s death.

When the grantor dies, the money from the insurance policy would flow into the box/trust and NOT into the estate of the grantor. The trustee would then pay out the money to the beneficiaries according to the trust instructions, free of estate tax.

Let’s get back to Harry and Wendy. In our original example, Harry and Wendy had an estate valued at $1,350,000 and two life insurance policies for $2,000,000 each. In our original example, Harry and Wendy died with a combined estate of $5,350,000 and a New Jersey estate tax bill of $306,800.

If Harry and Wendy did not own their life insurance policies themselves, but instead they (as grantors) created ILITs that owned the life insurance policies, then their estate would be valued at only $1,350,000 (and NOT $5,350,000). The $4,000,000 in life insurance owned by the ILITS (irrevocable trusts that are not included in the grantor’s estate) would pass to Ruben and Simon free of New Jersey Estate Tax. Governor Christie would have to find money for his security detail from somewhere else.

I know what you’re thinking—What’s the catch? And why don’t more people have ILITs?

This might surprise you, but the answer is usually NOT cost. Many of my clients are willing to pay between $1,500—$3,000 in legal fees to have an attorney prepare an ILIT to save $300,000 in estate taxes.

The answer usually relates to administration issues. There are mechanics related to the ILIT administration process that, to some clients, seem complicated. However, the administration process is not that burdensome. These are the steps in the creation and administration of an ILIT for a life insurance policy:

Step 1: Grantor creates the ILIT, appointing a trustee.

Step 2: Trustee gets a Tax ID number for the ILIT.

Step 3: Trustee opens a bank account for the ILIT.

Step 4: Trustee purchases a new life insurance policy owned by the ILIT, or the grantor transfers a current life insurance policy into the ILIT.

Step 5: Grantor pays the premiums into the bank account opened by the trustee. The premium payments usually qualify as gifts to the trust beneficiaries, so that no gift tax consequences result.

Step 6: Once the money hits the ILIT bank account, the trustee generates notices called “Crummey notices” and gives them to the beneficiaries. These notices tell the beneficiaries that there is money in the bank account and that the beneficiaries have a right to withdraw the monies (which qualifies the contribution by the grantor as a gift). BUT, the beneficiaries should not take out the money because if they did, there would be no funds to pay the insurance policy premiums, and no life insurance proceeds when the grantor dies.

Step 7: Trustee waits (usually 30 days) and then takes the money from the ILIT bank account and pays the premiums to the life insurance company.

Step 8: Repeat Steps 5-7 every year.

When the grantor dies, the life insurance proceeds go into the ILIT bank account, with significant estate tax savings to the beneficiaries.

Seems simple enough, right? In truth, it IS easy. However, most people tell me that they don’t want to go through the steps involved to actually administer the trust. Often clients tell me they don’t want to burden the trustee with having to create a bank account, generate Crummey notices, and pay the premiums every year.

Still other clients have existing insurance policies, and for current insurance policies there is a three year “look-back” period. That basically means that if you currently have a life insurance policy, and you put an existing policy into an ILIT, you have to survive three years for the ILIT to have any effect. If you die before the three years have passed, then the ILIT will not work the way it was intended, and the money would be taxed for estate tax.

There is work involved in creating and maintaining an ILIT. However, the IRS (and the New Jersey version of the IRS) will not let you save estate taxes without jumping through some hoops. If you’re willing to jump through those hoops, then you can save your children significant estate taxes.

Depending on the size of your estate, you should ask yourself: Do I want to pass all of my money to my children, even though I have to ask a trustee to do some work and I will have to pay for some documents, or do I want a piece of my estate going to Chris Christie? There is no one-size-fits-all answer, and every case and client is different. But at least now you can make an informed decision. Good luck!

Alec Borenstein, Esq., an estate-planning attorney, is a Teaneck resident with offices in Springfield and Brooklyn. His firm’s website is bmcestateplanning.com. If you’d like a free estate planning consultation in the comfort of your own home or office, please email [email protected].

By Alec Borenstein

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